I'm a husband, father, author, cyclist, sailor, travel addict, and former Silicon Valley software engineer. I've written 3 books and actively review books on this blog.
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Thursday, April 19, 2018

Recently, someone pointed me to the wired article about the risk parity fund that Wealthfront introduced and asked me why I wasn't even concerned enough to think about it? The honest answer is that Wealthfront has great credibility with me because of the way they handled customer issues in the past, so when I saw the risk parity e-mail I just said to myself, "This is Andy Rachleff introducing something cool, and I don't have to think about it."

Here's what happened 2 years ago, which has made my wife and I Wealthfront investors, instead of just customers who got a really good deal. Turbotax had indicated that our tax bill would be significantly reduced if we contributed to our IRAs. My IRA was with Vanguard, so I just did that. My wife's IRA was with Wealthfront. She initiated the process, but Wealthfront sent a confirmation e-mail that required that she click on a link to complete the process. Since we were traveling, she ignored the e-mail and forgot about it. The result was that her IRA contribution didn't go through and we were forced to file an amended return.

When Wealthfront found out about this (which happened to other customers, not just us), they were very apologetic. We got phone calls asking how they could make it up to us. They offered other customers a permanent waiver from fees, but since we already had that, their solution was to ask if we'd like to get stock options in Wealthfront instead. Yes, at this point, you're probably thinking about the irony that Wealthfront had screwed up, and the net result was that we ended up buying their stock and giving them money, but if you know anything about me and my wife, you know that it takes a very special company (with exceptional customer service) to get us to put money in.

Nevertheless, since I got prodded by a friend of mine, I contacted Andy Rachleff to ask about his response to the wired article. His response impressed me: Risk Parity is essentially taking academic research and bringing it to the masses. The idea is that lower volatility securities have higher risk-adjusted returns in the long run. The reason why bond funds have always returned lower is because they're much lower risk. So how would you take advantage of this? The answer is to use leverage: borrow money to buy bonds, multiplying the risk (and the returns). If you know me, you know that I'm allergic to borrowing money, but in this case, what's happening is that Wealthfront is borrowing at wholesale rates and the yield on the bonds exceed the interest the Risk Parity fund is paying, so there's no risk of being forced to sell if the bond market crashed. The expected return on this maneuver is high enough that at the 20% cap Wealthfront expects your overall returns to improve. The reason for the 20% cap is that tax loss harvesting is a big feature in a Wealthfront account, and there's no reasonable alternative for Wealthfront's Risk Parity fund to tax loss harvest into.

Wealthfront just announced yesterday that they're cutting expense ratios on the Risk Parity fund in half (to 0.25% from 0.5%), to avoid accusations that they're using the Risk Parity fund as a hidden profit center. The expectation is that cost savings from increased scale would also lead to further reductions in expense ratios in the future, just as Vanguard fund has done.

So, in response to people who're asking the question: would I still recommend Wealthfront? My answer is: "Yes, whole heartedly." I'm happy to be both a Wealthfront investor and customer. They've been very good about both fixing mistakes, and introducing features in their products that make money for their customers. I intend on adding more assets to my Wealthfront account in the future.